Munich Personal RePEc Archive
Post crisis blues
Beja, Edsel Jr.
Ateneo de Manila University
18 June 2010
Post-Crisis Blues
EDSEL L. BEJA, JR.∗
1997 Asian Crisis, 2008 Global Crisis, post-crisis, economic policy
E32, E61, F02, G01, H10, O20
A plethora of publications has appeared in the wake of the 2008 Global Crisis. As to be
expected, the present crisis is yet another opportunity to revisit the usefulness of
economics in addressing the problem. More importantly, there is also an opportunity for a
comparative analysis between two recent global crises (i.e., 1997 and 2008) and see what
really needs to be done. Since the 2008 Global Crisis is evolving even two years after it
emerged, what follows is necessarily gives a directional analysis.
∗ Ateneo de Manila University, Philippines;
Beyond the fact that the 1997 Asian Crisis and the 2008 Global Crisis are, in essence,
capitalist crises, there are important elements that warrant serious consideration. Five
elements are outlined below.
One element that both crises share is their deep and wide-ranging negative impacts in the
crisis-affected economies: both pushed the world to the brink of another economic
depression. Yet before these crises wreaked havoc, there was elation about the prospect
of unstoppable economic growth. There was a view that the last major crisis was far back
in history and could be considered irrelevant to current circumstances. Many analysts
even thought that advanced and developing economies had decoupled from each other;
that there was resiliency to any external shock; that there was room to proceed with the
current mode of policies. The situation was hopeful even in the developing economies
because, at last, economic development was possible despite the continued dominance of
the advanced economies in international capital and trade flows.
When the crises broke out, however, the notion of decoupled economies was
quickly quashed. Economies were, in fact, getting more tightly connected with each other
because of greater economic globalization. Because of the interconnections, external
shocks ― both good and bad ― turned out to be more forceful than before in impacting
economies. Negative shocks were magnified because capital and trade flows overreacted
by quickly retreating from crisis areas and, nevertheless, consolidating in advanced
economies, where financiers and investors felt relatively safer than elsewhere. Still, the impact of negative shocks was asymmetric both in 1997 and today; that is, the advanced
economies did better in sheltering their societies from harm than the developing
economies simply because the former had the resources to do so.
Asia was salvaged from its crisis in the late 1990s after the advanced economies
had put their acts together, so to speak, with the reduction of interest rates, deployment of
sizeable rescue packages,and reversal of the pro-cyclical prescriptions like those imposed
by the International Monetary Fund (IMF). There was concerted effort from the advanced
economies.
The challenge is greater in the case of the Global Crisis. If the experience of Japan
during the 1990s is any indication of what the advanced economies would have to endure
in the process of adjustment during and after a crisis, the advanced economies need to put
their acts together quickly and embark on unprecedented measures in order to stabilize
their economies and (yet again) avert an economic depression that would pull everyone
down as the world shrinks to find its balance.
There is now enough evidence showing that the Asian Crisis radically altered the
economic growth trajectories of the region (c.f., Cerra and Saxena 2005; Ghosh and
Chandrasekhar 2009; Park et al. 2010). The crisis-affected economies have yet to recover
their losses today, more than a decade past the crisis. In fact, they are still burdened with
large costs that seem too difficult to undo because of the limitations imposed by subdued
economic growth rates and external pressures. That the Global Crisis will change the
growth trajectories of the advanced economies and those affected by it is no longer an
issue. In fact, an L-shaped growth trajectory has been conceded to be the scenario for the
United States once the bottom of the Global Crisis has been reached, perhaps mimicking
the trajectory of Japan throughout its economic doldrums. The other advanced economies
will experience the same pattern, albeit of differing magnitudes, given the variations in
contexts and how the Global Crisis operates in their region.
The Global Crisis is not near the bottom of its contraction. Indeed, there has been
no easing up in its effects. What is disturbing is that the Global Crisis will push many
economies into serious difficulties and burden them with huge losses despite having no
direct involvement in the production of the crisis. It is also saddening, if not ironic, that developing economies will actually suffer more from the Global Crisis even if they are at
the sidelines of the global economy.
Deregulation and financial liberalization are common features to both the Asian Crisis
and Global Crisis; they are preconditions of the problem, so to speak. Basically, financial
systems were opened in response to demands for greater competition and freedom of
flows were not established or even removed in the process of deregulation and financial
liberalization. In fact, the way regulations were removed precluded the introduction of
new regulations to discipline international flows when it was found necessary to do so.
It is important to understand the context of deregulation and financial
liberalization. Right-wing economics and politics moved to remove market regulations;
they extolled the virtues of free markets and despised any form of government
intervention, which was identified as the cause of economic problems. It was believed
that markets always worked well because they are self-rational, self-regulating, and
therefore self-reproducing.Indeed, themereexistenceof markets is itself self-legitimizing
of their virtuosity and the possibilities they provide to economies. If markets were not
carrying out their role as understood, they would be easily replaced through competition
― it was thought that competition was enough to discipline the market. Government
intervention simply arrested progress, which is believed to be possible only with
unregulated markets.
Indeed, there was the assurance that society should not worry about market
operations because, on their own, markets evolved smoothly; they were preprogrammed
to reach equilibrium no matter what. All that was needed was to unleash the market. And
with economies performing well as the regulations were progressively being removed,
governments were emboldened to embark on more aggressive deregulation and financial
liberalization. Markets insisted to be free, to do whatever they desired, and to go
wherever they wished, and so governments had no choice, so to speak, but to deregulate
and liberalize their economies to accommodate the demand.
In the case of the Asian Crisis, massive capital and financial inflows ensued in the decade prior to 1997. Because the domestic productive capacities did not expand as fast
as the pace of the inflows, more funds went increasingly into speculative and
unproductive activities. By the early 1990s, the prices of stocks and assets such as real
estate had accelerated. With the weakened regulatory institutions in the region, capital
flight proceeded without restraint, as if governments were indulgent to the revolving
nature of the international flows. The large inflows also contributed to an expansion of
consumption as currencies appreciated and cheapened imports, in turn, undermining
end, flows of funds reinforced the consumption binges and unproductive expansion in the
region.
The Asian Crisis unveiled the weaknesses in the Asian region. Rapid economic
growth in the decade before 1997 was therefore only possible because capital continued
to flow to the region. With the crisis erupting in 1997, the flows stopped then reversed. In
the end, the region did not have enough funds to keep up with the outflows as capital
rushed to safety.
The debacle in 1997 radically changed the perception about Asian economies.
The region was quickly rebuffed for its cronyism, corruption, inefficiencies, and
structural rigidities, supposedly the causes of its collapse. Interestingly, these elements
were present all along even with Asian economies labeled as miracle economies. There
was, however, belated recognition that the main problem was liquidity: funds were not
enough to restart financial systems and governments were inutile to stop the bleeding of
their economies.
Not surprisingly, the Global Crisis shares the same trends with the Asian Crisis.
In the United States, where the Global Crisis erupted, the separation of commercial
banking and investment activities mandated by the Glass-Steagall Act of 1933 was
abolished with the passage of the Gramm-Leach-Bliley Financial Modernization Act of
1999, which effectively opened the United States financial system to free-for-all
competition among commercial banking, investment, securities, and insurance entities.
Of course, there were earlier pieces of legislation that weakened the Glass-Steagall Act of
1933. The rapid advances in computing power, information processing, and financial
know-how actually contributed to accelerating the process of removing regulations even as they facilitated the rapid expansion and sophistication of financial markets.
As financial activities progressed, more activities occurred outside regulatory
control; nobody knew how much transactions occurred in the so-called shadow financial
system. Besides, the removal of regulatory power pushed out authorities from intervening
in the financial markets. The aggressiveness of finance led to the creation of highly
sophisticated and very complex financial instruments that did not have secondary
markets; no one could resell the instruments when they went bad even at discount prices.
In other words, changes were increasingly focused on the secondary problems of
financial markets, that is, on market operations through the use of prices. Increasingly,
the primary problems of financial markets were downplayed, that is, the requisite
structures and institutions for market development were set aside as irrelevant to a
deregulated and financially liberalized economy. It was enough to assume that
deregulation and liberalization generated the demand for sound structures and
institutions. Again, the view was that markets cleared and the economy stabilized with
them and international flows were enough to discipline both the market and government.
Observe how the Global Crisis was caused by the wobbling of the United States
financial system, which in turn has threatened the collapse of the global financial system.
The Global Crisis showed once again that unregulated financial markets are not durable
and do not promise long-term benefits even in the most advanced economy. Put in
another way, the most sophisticated financial system is fragile. In economies with less
advanced financial systems, there is an embedded wisdom toward a precautionary
approach to deregulation and financial liberalization.
This time, however, the United States was caught in a gridlock-cum-vacuum
because the financial system was rapidly sucked out of liquidity even as it was infused
with huge funds. The United States problem burrowed deep into the financial system in
complex ways. Because of the linkages, a stalling United States financial sector stalls the
United States real sector. Owing to the international linkages between the real and
financial sectors, the United States problem was extended to the world. In short, the
nature of the problem is worse than that in 1997 because of the greater scope.
Recall that the Asian Crisis put to doubt the notion that markets could operate well by themselves. There were efforts to reign on markets through government
regulations in the wake of the Asian Crisis. After a while, though, as the world recovered
and, in due course, regained its pace of economic expansion during the 2000s, the
attitudes changed and government intervention was again seen to be unnecessary.
Interestingly, the Global Crisis revived the convictions declared due to the Asian Crisis,
namely, to redefine the international economic architecture and institute sound regulation
to manage international capital and trade flows.
institutions in order to soften market operations, to the fundamentals of production, and
to balanced economic growth, including the interactions of various factors, which are
needed for dynamic performance and improved economic welfare. Part of this
recollection is to recall how to re-embed finance in the economy and, again, make it
support production, contribute to growth, and help improve economic welfare.
People who believe in regulation should be tasked to run the regulatory agencies
and given ample room by government to execute regulations. It is meaningless to have
financial regulatory agencies or an integrated financial regulatory body when the people
placed there do not believe in regulation or think that any regulation is bad or see that the
removal of regulations is their mandate.
Re-regulation is in no way a license or approval to embark on authoritarianism or
antidemocratic measures. It is not even close to such view. Rather, it is a challenge to the
position that the un-regulated markets are the best ways to organize economic activities.
There is a need to reconsider the essential roles of government in a market economy and
find a balance between planning and market, to return to the fundamental purpose of
economic management. The fundamental principle that underpins re-regulation is the
promotion of a shared society wherein economic progress does not create extremes of
wealth and poverty, a shared society which provides access and creates opportunities for
everyone to overcome adversities and challenges through hard work and dedication,
tempered with the mutual responsibility to ensure that the economy continues to be
robust in the long term.
It is natural that success raises confidence. Equally natural is that continued success will
breed contempt of failure. There will always be a belief in the permanence of success and
the emergence of a new stage of advancement. Thus, a period of exuberance always
precedes a crash.
Another interesting parallel between the Asian and Global Crises is that they are
both results of economic successes that lasted for some time. The successful period was
thought to be the consequence of policies that stressed limited strategies or government
In Asia, the success of export-oriented growth strategy masked the ersatz nature
of economic progress. Asia was thought to be relatively coherent in constitution, relative
to the other developing regions. Indeed, two-and-a-half decades of continuous economic
expansion among roughly contiguous economies was unprecedented, even a miracle,
because such a scenario was statistically improbable (c.f., Jomo 2001). In fact, Asia was
thought to be the economic model that the developing world should emulate and aspire.
In a way, the Asian economies were Janus-faced economies. The region had
macroeconomicdiscipline andmaintained balance. It had adequate physical infrastructure
and provided basic social services like public education and health. Governments were
embedded in that they coordinated investment activities, supported the rising industries,
and encouraged reinvestment of capital for further production. More importantly, the
region became an aggressive exporter to the advanced economies.
Behindthefront of robustness,however,Asiahad uncompetitive domestic sectors.
Therewereaspects overlooked like increasing inequalities and environmental destruction.
Domestic adjustments were not pushed because economic growth masked the problems.
Rapid growth was thought to assuage demands for redistribution and environmental
sustainability.
By the 2000s, the Asian economies had geared back to growth momentum. The
export-oriented growth strategy was functioning again. New drivers of economic growth
emerged, like China and India, to supersede earlier drivers like Japan and South Korea.
Because of the painful experience with the Asian Crisis, Asian economies accumulated
international reserves as precautionary resources against illiquidity or another crisis.
This huge pool of Asian liquidity had to take some form and was placed somewhere in the interim that it was not utilized by the economies. Thus, there emerged
the international liquidity glut that characterized the 2000s.
The United States mainly but also other advanced economies were willing to take
in Asian and emerging economies’ international reserves because the funds financed
trade and fiscal deficits. The United States no longer produced most of the goods it
consumed, and so it imported a lot from the world, especially from China. It also did not
want to be worried about basic services for its workers and so it opened its doors to
than American workers.
United States authorities encouraged the situation by reducing interest rates and
keeping them low for a while despite key indicators pointing to the need for a reversal of
policy. The sustained capital inflows, of course, provided easy money that, in turn,
supported consumption binges and the rapid expansion of the United States financial
markets. With tougher competition, financial standards were lowered and thus emerged
the sub-prime mortgage bubble in the 2000s.
The capital flows into the United States and other advanced countries left little
resources to developing economies. China, for instance, has the largest international
reserves today, but a large part of its funds is locked in United States treasuries and other
fixed instruments. China and other developing economies are effectively providing
foreign aid to the United States. This unhealthy pattern, together with the fleeting nature
of flows because of deregulation and financial liberalization, has not only limited
economic development but also created and enhanced the existing vulnerabilities of
developing economies.
The United States enabled other economies to flourish because, as the global
consumer-of-last-resort, it gobbled up goods from the world. Again, global imbalances
have supported United States consumption since the 2000s. Needless to say, the current
international economic architecture requires one or two global consumer-of-last-resort
economies to enable global economic growth. Now that the United States is unable to
perform its role, the world is devastated. Still, the Global Crisis impacts the developing
economies in significant ways despite being at the margins of global economics.
!
There are two essences of the Asian Crisis and Global Crisis. The first is debt. Both crises
originated in borrowings. They are different only in terms of the nature of indebtedness
and its development. For the Asian Crisis, there was a mismatch of maturities and
liquidity, that is, the Asian economies borrowed funds in international currencies but lent
out in local currencies; they borrowed in short term but lent in long term. When the crisis
struck, economies found it difficult to meet debt obligations and respond to the massive
The Global Crisis, in contrast, originated in the securitization of debts.
Securitization is basically the creation of hybrid financial instruments through
(re)combining existing instruments then (re)selling them like conventional financial
instruments to, say, investment banks, hedge funds, insurance companies, and so forth.
The most recognized of these instruments because of the Global Crisis is the
collateralized debt obligation. The securitization process was thought to be safe, clean,
and transparent. Again, competition guaranteed that it would proceed just fine and bring
benefits to the economy in the long term.
Recall that in the conventional approach, banks extended loans to households and
businesses. If borrowers defaulted on the loans, banks suffered. Thus, there were strong
incentives for banks to ensure that good loans were made and the borrowers paid.
In the United States, things markedly changed in the 1990s. Banks shifted to the
so-called originate-and-distribute system in making loans. In the new approach, banks
still issued loans as before, but then they had other financial institutions or, on their own
if they had enough capitalization, packaged the loans into hybrid instruments. Notice that
the issuer of loans need not be the holder of loans. In contrast to the conventional
approach, there was no strong incentive to make good loans in the new approach.
With no strong regulations or monitors because of deregulation and financial
liberalization, the transactions continued like ordinary business, expanded, accelerated,
and then went out of hand. There was a perverse incentive to create more hybrid
instruments, sell them off, get bigger fees and bonuses, and then redo the process all over.
Why should market players worry about defaults when they got their big fees and
bonuses already? Besides, government allowed, if not encouraged, the expansion of such transactions.
Rating agencies contributed to the securitization process, too. The business of
rating agencies is exactly that: rating securities and related financial instruments. Their
business is fundamentally linked to selling and underwriting financial products. Put
simply, those who sold the hybrid instruments got rating agencies to rate their products.
The perverse incentive was to give very high ratings to earn more and not be concerned
about the integrity or truthfulness of hybrid instruments like collateralized debt
As competition in the financial market intensified, more loans were extended to
people who did not have the capacity to pay loans, or the so-called subprime borrowers.
Because United States housing mortgages were basically non-recourse debts, there was a
big problem right from the start.
It is easy to understand why loans need collateral. In the case of the United States
sub-prime lending, the collateral was (still) the house. But loans were non-recourse debts,
which means, in case of default, recovery of the loan is limited to the mortgaged
property. The rest of the borrower’s properties (if any) are not covered by the mortgage.
In short, it is possible for the borrower to return the mortgage to the bank because of
inability to pay then walk away. Indeed, since the housing bubble burst in 2007, people
walked away when they defaulted. There was therefore a perverse incentive on the part of
the borrower to not make good on the loan.
Besides, insurance against defaults was available to the bank, which is called
credit-default swaps or insurance derivatives. Simply put, the bank could purchase
insurance on a loan that was given in the sub-prime market to cover losses in case that
loan went bad. Again, there was perverse incentive to not make good loans.
What was overlooked during the securitization episode was that the transactions
evolved into hybrid instruments that remained outside regulatory controls. In short,
nobody recognized the profound changes in the financial system; in the end, nobody
knew the amount of toxic materials created during the securitization episode. Moreover,
the hybrid instruments did not have secondary markets. In short, nobody could resell their
toxic materials if people did not want to hold them anymore, even at discount prices.
What made things worse is that these instruments were actually not backed by real value, thus it was difficult to stabilize the situation when the crisis broke out in the financial
system. And because the regulatory infrastructure was decimated throughout the 1990s, it
was difficult to intervene in the financial system. In short, securitization set the course
toward catastrophe. After the bubble burst, a financial gridlock-cum-vacuum emerged.
The Global Crisis is, however, a bigger problem than the Asian Crisis simply
because, first, the advanced economies are affected and, second, which is a consequence
of the first point, it is global in scope. Interestingly, the Global Crisis obliged
would have been unimaginable during the Asian Crisis, when governments were forced
to close and privatize the erring banking and financial institutions and corporate
enterprises. At the same time, massive bail-out packages were provided to failing
institutions and enterprises, which, again, were ruled out as a viable response during the
Asian Crisis.
As a matter of fact, several advanced economies have posited that nationalization
is a necessary step to distinguish the good from the bad assets, remove the toxic ones, and
facilitate the recapitalization of financial institutions to restart capital flows. But that idea
is mistaken because nationalization should be done primarily to secure the real productive
sector and not to alleviate the problems that the financial sector created on itself.
In the United States, a serious financial cleanup is needed. Bailout is definitely an
expensive endeavor. It needs to be acknowledged, though, that the United States
capitalist system today is characterized as “corporate welfarism,” or a predisposition to
first attend to the demands of corporate and financial interests and not to have second
thoughts about cutting budgets for healthcare, education, housing, and other basic
services. Like it or not, United States taxpayers are going to assume a disproportionate
burden of the bailout as the toxic assets are socialized. With the labor already weak and
powerless after years of assault, the working class is going to suffer the most despite the
bailout. It seems that those who profited from their irresponsible actions would not be
asked to take the burden of paying for the bailout. There is simply no socialization of
profits for the rich and powerful.
As the events unfolded in 2008, bailout was extended to giant finance players like
Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley, Goldman Sachs, and Citigroup; insurers like Fannie Mae, Freddie Mac, and American International Group;
regional banks like Washington Mutual; and auto companies like General Motors, Ford,
and Chrysler.
The United States financial sector needs to bail itself out because the alternative
scenario of a United States financial collapse is worse in terms of its impact on its
economy and the world, as well as on global security. The alternative scenario of reliving
another depression is unacceptable to the United States and the world.
States authorities can carry it out because its economy does not have a currency
constraint problem, unlike most other economies. Put another way, United States
authorities can provide the liquidity needed to have a successful bailout and save the
financial system by simply allowing the release of money.
But the fundamental issue is whether United States authorities realize that a
bailout would necessarily help those who profited and took advantage of the situation that
brought the United States financial system to a brink of collapse or that the bailout would
necessarily help those who were complacent in building the United States productive
sector. A related important issue is whether United States authorities have the seriousness
to fight the good cause and take up actions in good faith to avert the greater costs
because, in the event of a financial collapse, there would be no “soft landing” for
everyone. An equally important issue is whether United States authorities would run after
those who placed the financial system in the United States at the brink of collapse or, for
other economies, to break down.
Because of the financial mess, those who placed their money in, say, pension
funds for a good objective will not be able to look forward to a secure retirement. Many
people will lose incomes, jobs, and houses as the financial mess spreads through the
United States economy. Since it is not well understood how the money will be recovered,
bailout will create a huge hole in the financial system even if it saves the financial
markets. As those who profited from irresponsible actions are not going to take any
burden, bailout will strengthen the view that the United States has become a society that
protects the wealthy and powerful and gives token care to the poor and powerless. The
bailout will penalize the taxpayers for a long time, even as the United States authorities purge the toxic financial products.
No doubt, the United States financial mess requires a quick and solid resolution
because, even at the interim of the Global Crisis, the costs have become too large to be
fathomed. After that, there will be serious re-regulation to discipline capital, resuscitate
the financial regulatory structures and pull the financial system out from its setup that
encourages financial casinos and, more importantly, make finance once again serve the
people rather than the reverse. There will also be serious actions against those who took
Like the Asian Crisis, the Global Crisis originated in a bubble. Bubbles do not
usually have any effect beyond the domestic sector. The Asian Crisis evolved into a more
virulent crisis because the advanced economies and international organizations like the
IMF were disinclined to provide assistance to extinguish the problem as it hit other
regions. The opportunistic nature of the intervention did not help ease the problem in
Asia because the economic contraction led to a general doubt about the integrity of
developing economies in general. Economic integration and globalization also facilitated
the transmission of the problem.
The Global Crisis, however, is different from the Asian Crisis because the United
States bubble has burrowed quite deeply into the United States financial system.
Securitization has transformed the bubble in complex and intractable ways. Owing to the
domestic linkages, a stalling United States financial sector stalls its real productive sector.
Consider the following transmission. The collapse of the housing industry affects
the sectors that are directly connected to housing, like construction and materials,
furnishing, and utilities, and eventually the workers and incomes in these associated
sectors as well. Of course, it does not necessarily mean that if the housing industry
collapses it will automatically affect the other real sectors, say, automobile, airline,
shipping, and so forth.
There may be secondary effects of a housing industry collapse. For instance, as
the furnishing industry is adversely affected, people lose their jobs and income. Thus,
there may be fewer people who want to travel, thereby affecting the airline industry in
due course. The same goes for industries linked to airlines, and so forth. In short, a
problem like housing collapse may lead to secondary problems that can immobilize the whole real sector of the economy. Of course, the speed of transmission and extent of the
effect greatly depend on the health of the economy.
The housing sector and the other industries are linked to the financial system. It is
possible for a housing company to put up its own lending company, providing people
who bought houses with access to some form of financing. Similarly, a conglomerate
may put up its own bank to establish some form of direct payment facility for its clients.
These linkages make the financial system function like the circulatory system of the
Unlike the real sectors of the economy, the financial system has direct linkages to
all parts of the economy. In the case of the United States financial crisis, companies lent
to each other but turned a blind eye on the unusual situation: no one actually had enough
money to pay all the obligations. It was generally thought that nothing unusual was
happening because, again, competition was extensive. Then the bubble burst, the “house
of cards” built with housing mortgages fell apart, and a major heart attack to the financial
system occurred incapacitating the United States. As the repercussions in the real sector
manifested, the financial sector found that it did not have enough money to support the
untangling of debts.
The linkages within the United States also serve as the conduit for extending the
United States mess to the global economy. With the retreat of capital to the advanced
economies for security, the real sector of developing economies will suffer as economic
contractions ensue following reduced capital and trade flows. This way, the Global Crisis
is like the Asian Crisis because in the latter, capital fled the region to seek safer places,
especially the United States.
The Global Crisis is similar to the Asian Crisis because of the linkages across the
financial and real sectors. The problem in the United States hit the European and Asian
financial systems as they were unable to recover their exposures. As their financial
system stalled, their real sectors were compromised in the end. Because economies are
now rather tightly linked to each other, the slowdown resulted in secondary effects on
other economies as well. Thus, as advanced and developing economies slowed down, the
world fell into economic trouble.
During the Asian Crisis, capital pulled out from the region and shifted to the advanced economies to start another bubble, so the amount of capital in the end remained
intact or, at least, capital was able to recover the losses from the Asian Crisis rather
quickly. In fact, the same general process could be observed with the Mexican Crisis in
1994, Brazil and Russia Crises in 1998, Turkish Crisis in 2000-2001, and Argentine
Crisis in 2001–2002. Even the United States dot-com bubble in 2001 came from the same
cycle of boom and bust.
This time, the Global Crisis hit capital in its core. Capital was vacuous because it
when the bubble erupted in 2007, asset evaporation ensued. Large offs and
write-downs have continued since 2008, creating a downward spiral of valuation and
sentiments. The effect is that capital will now have much difficulty reconstituting or
restoring itself in the post-crisis period. This time, bubbles will not be quick to emerge.
Besides, the amount of capital will not be enough to start another bubble, at least during
the mediate post-crisis period. The failure of another bubble will therefore be problematic
for reviving global economic growth.
Of course, there will be subsequent problems, especially in developing
economies, where capital is already scarce. In fact, some of them already had difficulties
repaying their debts before the Global Crisis. Poor ones will face a much tougher
problem in meeting their debt obligations. If debt problems emerge, certainly, there will
be another layer of complications to the Global Crisis.
" #$ %
The Global Crisis emerged in the heart of the world. It did not occur in some developing
economy with faulty financial institutions or broken politics, but in the United States, the
richest, arguably the most democratic, country with the most advanced financial system
in the world. While serious crises occurred in advanced economies in the past, like the
1980s United States savings and loans debacle, the 1990s Scandinavian banking crises, or
the 1990s European Monetary System breakdown, none of them actually threatened the
world. Perhaps this is because there is something odd with the present-day variety of
United States capitalism, or the Global Crisis came out in the United States that it was not
expected.
Contrary to popular perception, the Global Crisis was actually foreseen by a
number of analysts. Nobel Laureate Joseph Stiglitz and economists like Robert Shiller
and Nouriel Roubini noticed the alarming trends before 2007. There are other analysts
who raised the alarms, of course. The United States Federal Bureau of Investigation
warned, in 2004, of problematic and unhealthy financial practices linked to securitization.
Warren Buffet warned of the dangers of derivatives, as early as 2002, calling them
“financial weapons of mass destruction” (c.f., Berskshire Hathaway 2002). What is
warnings, including in the United States. It seems that the world was content to dismiss
these analysts as doomsayers (c.f., Greenspan 2007), or, as in the case of Asia in the
1990s, authorities did not want to let go of the vision that global economic performance
was heading to a higher level of advancement. Perhaps, authorities and their analysts
operated within a setup that predisposed them to take self-serving analyses which rule out
the possibility of a brewing problem. If their analyses succeed in identifying the problem,
the setup is such that it precludes them from taking actions because doing so risks the loss
of confidence and produce panic.
Of course, there is the matter that the Global Crisis, like earlier crises, is a
systemic problem inherent in capitalism. That is, while no economic system is free of
crises, it is argued that only capitalism is genetically structured to fall periodically into
crises. But people find it difficult to accept that capitalism is fundamentally flawed. As
such, it is better to forget about the flaws. It is relaxing to believe in the infallibility of
capitalism and to dismiss dissenters as doomsayers. The onslaught against alternative
proposals has been successful because the notions that the capitalist system will
eventually sort itself out if crises occur and that competition will temper it dominated
policy and analysis and so crises are unimportant dominate the analysis of the Global
Crisis. The situation is unfortunate because the collapse of capitalism today is an
occasion to engage in a serious fundamental analysis of the capitalist system.
1
What are the policy directions to revive economic growth and prevent the occurrence of
another crisis? Five considerations for the post crisis period are presented below.
&
The first policy challenge in the wake of the Asian Crisis was reigniting economic growth
in the region. The same applies to the economies adversely affected by the Global Crisis.
As in the Asian Crisis, sustaining growth over the long term across the world will, in fact,
be the bigger challenge in the post-Global Crisis period. Recall that after the Asian Crisis
growth trajectories of the crisis-affected economies did not return to their previous path.
1
This pattern need not reoccur if outputs, incomes, and jobs expanded in the post-crisis
period.
In the interim, the world is seeing the advanced economies on a downward spiral.
The contractions have adverse impacts on the economic performance of developing
economies that, in turn, can aggravate the conditions of the poor who comprise more than
half of the world’s population.2 The collective decline of economies will be problematic
because global economic welfare will fall, too. With the bottom of the Global Crisis not
yet in sight there are serious concerns about the depth of the dive and, accordingly, the
magnitude of the damages. Recovering these costs will be a huge challenge to economies
in the post-crisis period.
It is imperative therefore to prevent the Global Crisis from escalating into global
collapse. The scenario of a depression must not be allowed to happen. As such, stimulus
programs are needed to pull economies out of the crisis. Put simply, aggressive spending
is needed to improve the outlook in the succeeding years. The purpose is not only to
realize an improvement today but also to reinvigorate the economy for the future. To
have profound effects, the stimulus programs need to emphasize complementarities,
exploit scale economies, and minimize duplication so that there will be generalized
expansion across sectors and economies.
Stimulus spending is crucial during a crisis because it is quick to stimulate
economic growth. But it needs to be timely so that spending will actually contribute to
the expansion of production, generation of jobs, and increase in incomes. Enlarged
income, in turn, creates successive expansions that materialize into larger gain than the
initial outlay.
Stimulus spending needs to be coordinated so that demand will be spread out
across economic sectors. The challenge is more difficult in the case of the Global Crisis
because the spending also needs to be coordinated across economies to see improvements
in global economic performance. At the same time, it is important that stimulus spending
is sustained in the medium term to avoid an economic relapse.
Depending on the domestic capacity, a meaningful stimulus spending needs to be
2
This statistics is based on the US$2.50 daily benchmark to be classified as international poor. With the
between 2 and 5 percent of gross domestic product (GDP) over a four- to five-year
period, with gradual reductions midway into the program.3 A conservative determination
is to first obtain the total contraction as a share of GDP at the bottom of the crisis, then
divide the figure by four or five years to get the size of a stimulus program for each year.4
For example, if the total contraction reached, say, 10 percent of GDP at the end of the
crisis, then the stimulus spending needs to be in the range of 2 to 2.5 percent each year.
Recall that this approach could bring an economy back to its pre-crisis trend. To recoup
the costs, however, stimulus spending needs to exceed the calculated low-end amount.
Of course, downgrading economic growth targets is inevitable during crises; but it
is precisely because of this that stimulus spending needs to be introduced quickly and to
be as decisive as possible in order to reverse the distressed scenario swiftly. In the ideal
scenario, reduction in spending is done once the economy is back on track to its original
growth trajectory. At this stage, it is important to institute counter-cyclical spending.
Thus, there is a need to set up a mechanism that will enable interventions to manage
growth fluctuations via spending. Because of the Asian Crisis experience, there is
consciousness that improving the economic performance of crisis-affected economies is a
priority concern before going into the structural changes.
!'' (
A major mistake during the Asian Crisis was the misdiagnosis of the crisis and, because
of that, the wrong prescriptions. The Asian Crisis was thought to be a current account
problem, forcing the crisis-affected economies to execute current account measures. In
actuality, the Asian Crisis was more of a capital account crisis which affected the current account, since economies suffered from liquidity as capital flows ran out.
Recall that the Asian Crisis was attributed to cronyism, corruption, and so forth,
so the prescriptions focused on structural changes and other reforms that were not
directly related to the liquidity problem faced by the crisis-affected economies. Of course,
entrenched interests were upset. Elites did not support the reforms, resulting in the mere
3
Two percent of total output is a generic IMF prescription for stimulus programs.
4
Obviously, the calculation assumes perfect foresight to determine the bottom of a crisis. In the absence of
token acceptance of the prescriptions handed by the IMF and others. In the end, there was
default on the reforms. If the liquidity problem were addressed head on (i.e., with access
to funds to stabilize the situation), a bitter crisis could have been avoided. There were
other mistakes, of course. But, again, the Asian Crisis escalated the way it did because of
the incorrect analysis and prescriptions.
In a way, the Global Crisis started out as the result of incorrect analysis and
prescriptions. As mentioned earlier, as early as 2004, warnings pointed to unhealthy
financial market practices. Warnings in 2006 pointed to an impending crisis in the United
States housing sector. It is unlikely that the United States Federal Reserve did not see the
unhealthy trends. Recall, for instance, how the United States stock market adjusted in
December 1996 after then Federal Reserve Chairman Alan Greenspan marginally
commented in a speech that the 1990s stock market boom exhibited “irrational
exuberance.” In due course, the dot-com bubble burst.
In other words, if United States authorities wanted to act to deal with a potential
problem, they did so with binding threats of intervention and regulation. The fact of the
matter is that the United States Federal Reserve refused to intervene in the 2000s. To the
Federal Reserve, the brewing problem was merely froth in the financial system that
would just disappear when competition fixed the exuberance. Accordingly, the Federal
Reserve did not acknowledge a housing bubble problem. It even went on to relax its
monetary policy and maintained loose policy for too long. It also supported the removal
of the remaining safeguards against speculative activities. In a way, the Federal Reserve
acquiesced to the financial markets.
Market players, in turn, were emboldened to engage in more speculative activities. There were also implicit promises that government would lend a hand in the
event that help was needed, strengthening the notion that market players were too big to
fail. In short, not only were structures and institutions weakened with deregulation and
financial liberalization; the incentives were also unsound and the environment
encouraged speculation.
Moral hazard was part of the problem. On one level, there was hesitation to say
that there was a problem in the financial system despite the deregulation and financial
would break out. If it did not do anything, however, a crisis would still occur. In these
alternative scenarios, the latter was easier to pursue.
The above argument avoids the issue of the roles of financial regulators, which
are, necessarily, to ensure the soundness of the financial system and make it resilient
against shocks, ascertain the veracity of financial products sold in the economy or
elsewhere, check market players if they engage in financial casinos or prey on people or
fool everyone else to consume financial products that are unsafe for the economy in the
end, avoid situations which will bind the government to bail out those who acted
irresponsibly, impose the burden on those who acted carelessly, and, more importantly,
discipline capital so that it supports the economy. In addition, there must be effective
regulation and capacity to discipline market players. Apparently, when the situation was
ripe for a financial crash, Federal Reserve did not and could not act to extinguish a crisis.
The bailout and rescue activities comprised the first phase of the effort to
resuscitate the financial system, and the stimulus programs are the next steps.
Institutional reforms are, without a doubt, desperately needed to address the source of the
problem, but they are to be done in the appropriate fashion and timing.
An important lesson from the Asian Crisis is that fundamental reforms should be
introduced once the crisis-affected economies are on a steady course to economic
recovery, which in itself is important to sustain the reforms. Some measures could be
urgent, like strengthening the rule of law and apprehending culprits, which signal the
seriousness of government and convey the message that things would not go back to the
way things were before the crisis. Safety nets are needed to minimize the adverse impact
of the crisis on the poor and the vulnerable. In such cases, actions need to be creatively introduced by the authorities to convey the correct message that government defends
public interest not private interests.
It is apparent when reviewing past major crises, like the Great Depression of the
1930s, that urgent measures were done without delay and reforms were introduced in due
course.5 The Federal Deposit Insurance Corporation, the Securities and Exchange
5
There were also policy mistakes. In 1937, the Roosevelt administration decided to balance the budget.
The result was a recession. Realizing the mistake, the Roosevelt administration changed direction and
Commission, and other agencies, as well as social security, wage and labor standards, and
so forth, were introduced by the mid-1930s. An alphabet soup of regulatory agencies was
prepared between the 1930s and the 1960s.
Together with regulatory reforms, the United States government raised taxes on
the elites. Naturally, such measures were objectionable. In the end, however, the policy
transformed the United States society. In particular, taxes on the elites and, subsequently
income taxes as well, produced the great compression in wealth and inequality, creating
the middle-income American society that attracted many people to the United States (c.f.,
Piketty and Saez 2003 and Krugman 2007; for the experience of advanced economies,
see Piketty and Saez 2006). Regulatory agencies produced a managed economy.
Eventually, there were parallel growths in wages, profits, and accumulation which
sustained expansions in production, consumption, and economic welfare. Thus, the
United States experienced the longest expansion in the post-World War II period ending
in the 1970s.
At the broader level, reforms are needed to repair the capitalist systems that were
damaged by unbridled deregulation and financial liberalization. Equally crucial are
measures to take care of the frightening challenges to society caused by mindless
capitalist expansions, namely, climate change and environmental destruction. Reforms
are likewise necessary to shift attitudes from focusing on corporate profitability to
emphasizing public safety and security.
Measures that penalize those that funnel resources into useless and destructive
activities have to be enacted in the post-Global Crisis period. Those who engage in
speculation need to be liable for their mistakes. In the meantime, governments must institute caps on irresponsible and callous actions that seem insensitive to the Global
Crisis. Reforms that encourage and reward productive activities, initiative, and good
business need to be enacted, too. At the same time, reforms like redistribution and
income and wealth taxation have to be revisited.
Lastly, research and development needs to be stressed in order for societies to
devise context-specific measures, strengthen regulatory institutions, and improve
bureaucracies. It is also necessary in finding alternative routes to economic progress so
global economy. In areas where agriculture plays a key role in terms of employment and
income, there needs to be greater attention to, say, enhancing agricultural and technical
services to improve farming and harvesting techniques, as well as explore viable off-farm
livelihood programs, especially during the growing season. Obviously, free public
education and health services and employment must be guaranteed to anyone who wishes
to attend school, needs medical care, and wants work. Skills improvement and training,
together with technological research and advancement, are key components of an
invigorated capitalist system. Their availability ― both the quantities and qualities ―
will bring about sustained growth. They are all needed in the post-Global Crisis period in
order to recoup quickly the lost opportunities.
) $ ' *
The challenges learned from the Asian Crisis with regard to capital and trade flows are
even more relevant to the Global Crisis. Deregulation and financial liberalization without
the corresponding regulatory reforms to strengthen institutions and respond to the new
conditions, together, were the preconditions for the Asian Crisis. In the end, with the
virulence of the crisis, massive capital flowed out from the region while trade contracted,
eliminating the source of funds for debt financing, and pushed economies to very difficult
and painful experience.
By 2000, capital had started to flow back to developing economies. More funds
returned to Asia. However, globally, these flows remained predominantly within the
advanced economies. A fraction of global flows actually went to the developing
economies, albeit to a dozen of high-performing developing economies. The other areas, like Sub-Saharan Africa, received very little capital flows and did not have access to
capital to support economic growth.
With the crises in the late 1990s and earlier 2000s, capital was reluctant to flow to
the developing economies without guarantees or privileges, like tax breaks or safe
passage if it wanted to take the exit. Meanwhile, unrecorded flows intensified as capital
flowed in because there were few regulations in place. Any adverse development
amplified the rush to the exit. At the same time, capital could circumvent the remaining
regulations.
Moreover, capital flows became more short term in character. The composition of
flows also turned out to be increasingly liabilities rather than assets and green-field
investments. The consequence was that capital did not take root in the domestic
economy, nor did it contribute to enhancing productive economic activities. In short,
capital was only after profits then quickly left to search for other profitable opportunities.
As Asia started to stabilize, efforts toward further deregulation and financial
liberalization were revived. The view changed from deregulation and financial
liberalization as preconditions for the Asian Crisis to being indispensable measures in the
post-crisis to pull the region to higher growth trajectories. Indeed, the latter view was the
argument in the early 1990s as Asia had enjoyed uninterrupted expansion since the
1980s. With governments instituting financial measures and other reforms like capital
adequacy and accounting standards, confidence was raised that even if deregulation and
financial liberalization were pursued the old way, the safeguards introduced were already
sufficient to forestall another crisis. Of course, governments were cautious with
embracing capital flows but more amenable to the removal of regulations.
Even today, capital flow management remains weak. In regard to the capacity to
control capital flows, such as directing capital into the productive sectors, affecting the
composition of the flows from short-term to long-term capital, or preserving capital in the
economy, developing economies in general remain weak. Malaysia removed its capital
controls in 1999 and, thus far, there is no comparable capital management setup in place
there. Not surprisingly, when capital controls were removed in 1999, Malaysia
experienced a massive outflow of capital. As the world gathered economic momentum in the early 2000s, capital management techniques became more difficult to introduce in
developing economies; capital became stronger and launched a capital strike against an
economy that contemplates regulating capital flows, causing problems to the economy.
There also remain problems in trade flows management. Global trade continues to
be predominantly within advanced economies. The developing economies, on the other
hand, take part in a small portion of global trade, albeit high-performing economies like
those in Asia are able to participate more than others economies. Trade access and
convictions of the advanced and developing economies that greater trade is good for
economic performance and the international community.
An associated problem concerns the composition of trade flows from the
advanced and developing economies. What remains consistent is that developing
economies trade mainly in primary or low- to medium-technology goods, which are
easily absorbed by the advanced economies. There have been improvements, but these
are seen only in the high-performing developing economies. In general, though,
developing economies cannot easily absorb the flows in value manufactures or
high-technology goods, which differentiates the trade in the advanced economies. The latter’s
goods are more expensive relative to those of the developing economies, which therefore
creates an imbalance in trade financing.
The asymmetry of global trade flows happens partly because investments into the
developing economies do not often allow transfer of technology or even permit
adaptation to help ignite the drive for the formation of domestic industries. Trade flows
management has focused on the protection of intellectual property rights and the
standardization of production that little attention is given to how to utilize existing
technologies to create industrial diversity across economies. Developing economies are
thus forced to specialize in diminishing returns intensive production that fails to not only
bring in large returns because the prices of their goods decline with greater production
but also generate large employment opportunities for workers. Participation in global
trade turns out to be limited and potential for economic growth is constrained.
Trade management techniques that result in solid industrialization and trade
deepening are important in transforming the developing economies. Each economy needs the policy space to be able to design industrial policies that account for local
characteristics and conditions. The setup may include industrial protection coupled with
the appropriate incentives for competition and the weaning of industries from protection
as industrialization takes root. For instance, protection may be linked to utilizing local
resources and labor or attaining bigger shares of the global markets, and so forth. Since
industrial deepening is a long-term endeavor, adequate domestic capacity is crucial to
succeed in this complex engagement. As with the capital management techniques, trade
course of development that is appropriate to the economy.
There are reemerging challenges that the Global Crisis brought to the surface. The
first concerns the reversal of capital flows as the Global Crisis intensified. Because
economic contraction continues and the turning point of the advanced economies is not
yet in sight, capital flees the developing economies to seek safety in the advanced
economies. Meanwhile, developing economies face more difficulties in getting financing
to meet present obligations because capital flows have significantly slowed down, if not
stopped, the cost of financing has markedly increased, or investments are already
withdrawing from the rest of the world and are consolidating in the advanced economies.
Rating agencies also downgrade the investment appraisal of developing economies.
These changes actually began in 2007 but have worsened since 2008.
With the intensifying capital outflows, developing economies are facing grave
difficulties in sustaining their economic performance because of trade flows contraction.
With the Global Crisis escalating in 2009, there is lower demand from advanced
economies for goods from the developing economies, which complicates foreign
exchange constraints that deepen the external debt financing problem and the ability to
obtain inputs of production. As above, there is negative feedback that ultimately reduces
economic growth. There are added complications, like the currencies and stock markets
get battered and then international reserves are depleted. The negative feedback from this
side of the economy accelerates the fall in growth.
Naturally, reduced capital flows, coupled with the hesitation to extend credit to
the developing economies, add risk. With remittance flows decreasing because jobs and
wages fall during crises, developing economies have fewer options in terms of accessing credit or rolling over existing debts. The most serious risk that the Global Crisis places on
the developing economies is debt defaults which, if they materialize, will transform the
Global Crisis into a depression. Therefore, capital and trade management techniques are
actually more pressing today than in the late 1990s.
The above issues concerning capital and trade flows management deal with the
macroeconomic dimensions. But the Global Crisis has brought forward the
microeconomic dimensions concerning capital and trade flows. On the former aspect,
financial system that encompasses banking, securities, insurance, and other institutions to
manage risk and direct resources to productive economic activities. As explained in the
first part of the postscript, deregulation and financial liberalization facilitated the removal
of the setup that compartmentalized the financial system to avoid speculative and
unhealthy activities. Re-regulation of capital flows is now needed to put the economy
back in shape, with capital supporting domestic productive activities onto smooth
economic expansion, thereby contributing to the improvement of public welfare rather
than the other way around.
Obviously, capital and trade flows management in developing economies needs to
address both resource direction and supervision of risk to avoid crises. In advanced
economies, on the other hand, the task is more on regulation to take control of risk rather
than direct resources, since their financial markets are more developed than elsewhere.
What needs to be stressed is that capital and trade flows management entails separate but
complementary policies. In this regard, governments have even more important roles to
play today in balancing strategies with respect to both domestic objectives and
international cooperation because, if mismanaged, either one can be deleterious to
economic growth.
+ & ,
In fact, one of the encouraging developments because of the Global Crisis is a marked
shift from market fundamentalism that had characterized economic management since the
1970s toward more active government participation. Governments need to be steadfast in
their task to protect their societies. They are once again reminded that they can actually lessen the frequency and severity of crises if they fortify their economies with solid
institutions, inoculate themselves with reasonable regulations and vigorous supervision,
and, at the same time, institute changes to respond to changing conditions. There is no
doubt that markets can be efficient if they are efficiently regulated as well. And there is
also no question that more competition is possible with more rules (c.f., Helleiner 1994,
Vogel 1996, and Yeung 1998).
Of course, governments need to build capacity so that they are able to fairly
integrity at the initial stages rather than after a crisis erupts. That is, they need to assume
a precautionary rather than reactionary stance in economic management. Governments
also need to enhance their bureaucracies in order to have a base on which to launch a
strategic course for stable economic performance. They likewise need to be able to
achieve a balance of competing demands coming from beneficiaries and learn when to
withdraw support because it is no longer needed, unleash competition at the right time
and amount, or return intervention when needed. While the role of government is
contingent on the prevailing trends that are likewise changing, governments cannot,
under any circumstance, forego their regulatory responsibilities over their economies.
Needless to say, regulatory capture and corruption emasculate governments from doing
their job.
Principled leadership is of the essence during crises. What the Global Crisis
revealed is that corporate interests have captured the government and transformed the
economy to fit their interests. For instance, as the Global Crisis evolved, the United
States did not throw its weight to discipline capital. In fact, as pointed out in the first
section of this postscript, the United States government progressively removed
regulations to respond to the demands of capital. It was a long process of transformation,
but eventually, government was dominated by capital when elites entered government to
run it. In the end, public interest was tossed out and capital defined change as it pleased.
Capital was therefore not deployed to support the economy; rather, the economy was
made to serve capital. The US government, for example, embarked on massive bailout
and rescue operations to save the bankers (not the banking system) because they were
unable to reign on capital.
With the Global Crisis, governments resolved to salvage their position, strengthen
their capacity, and embed once again in the economy, so that they would regain their
positions as key agents of transformation. It is worth noting that, in the history of the
advanced economies, their governments creatively intervened in the economy to promote
and manage advancement. The interventions came in different forms like industrial
policies, regulations, preferential treatment of the domestic sector while pushing it to
engage the external sector, capital flow management to maintain economic stability, and
